The investment question we never ask

From Gareth Stokes, MoneyWeek editor, SA

Dear Money Morning reader,

While paging through the financial media you’re bombarded with information. Reporters can’t wait to tell you how much the market has moved since yesterday. They drawl on endlessly about the daily swing-and-roundabout variations in company stock prices. And circling above them – like vultures over a rotting carcass – the analysts and economists queue up to offer their reason for each and every development. The JSE opened firmer yesterday on higher resources prices… mining shares were higher at 13h00 on better than expected Chinese demand figures… stockpiling of copper and other commodities in China is creating artificial demand. And so it continues.

In adhering to the supply and demand theory of economics taught at universities around the world, we must assume this abundant market commentary is rooted in demand. The public, it seems, wants up-to-the-minute information on their investment performance. In reality you’re probably experiencing the greatest supply/demand mismatch ever. To begin with the vast majority of newspaper readers aren’t directly involved in any type of investing activity. They might be members of pension funds or own a few unit trusts, but they hardly ever reach for the phone to get a line of Standard Bank stock. The second problem with this information overload is the vast majority of investors don’t (or shouldn’t) give a hoot about what the market did between 11:05 and 12:05 on Wednesday, 10 June 2008.

What’s all the fuss about then? As we spent some time analysing this market noise it occurred to us there’s an investment question nobody ever asks.

That question is: “Why do we invest in the first place?” To answer it we need to split investors into two groups. The first is the retirement saver. This individual invests in equities as part of a comprehensive plan to ensure an acceptable standard of living upon retirement. The second is the professional trader (some use the term speculator, punter or gambler) who buys and sells equities to generate an income. Both fit the broad definition of an investor: someone who commits money to investment products with the expectation of financial return.

But they’re differentiated by a number of key factors. One is their attitude to risk. A retirement saver’s primary goal is to minimise risk and achieve a consistent inflation beating return. The professional trader, on the other hand, will accept higher risk in the hope of earning an immediate higher-than-average profit. Another is the investment timeframe. A retirement saver will commit funds to the stock market for long periods of time to smooth the impact of market volatility. In contrast the trader thrives on volatility. And finally they have juxtaposed return expectations. A South African retirement saver will be happy with a real return (returns on his entire investment portfolio less inflation) of 5% after costs. Over the 105-years spanning 1900 to 2005 South African shares provided real returns of 7.3%, explaining the importance of this asset class in the retirement saver’s portfolio. A speculator is less concerned with returns and compounding than immediate profit – and will use any financial instrument capable of satisfying this goal.

Before you commit money to the stock market you must understand your goal. If you’re in equities to make a quick buck then by all means digest the daily market noise. We doubt it will help your investment decisions – but at least you’ll keep abreast of your daily profits and losses. If, like the majority of stock market hacks, you’re trying to put something away for retirement, you shouldn’t pay more than fleeting attention to short-term market gyrations.

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Turning to the markets...

The JSE all share index closed up 1.03% yesterday. The gold mining index lost 1.28%. Resources added 1.51%. Banks and financials climbed 1.67% and 0.99% respectively. Industrials collected 0.47% and the platinum mining index fell 2.56%.

London’s FTSE100 closed up 0.73%. The Dow Jones shed 0.27% and the Nasdaq lost 0.38%.

Tokyo’s Nikkei closed 0.14% up. Hong Kong’s Hang Seng plummeted 4.38%.

Brent crude is currently trading at $71.42 per barrel.

Spot gold’s trading at $957.10 and platinum was last quoted at $1,267.50.

And here’s how the rand is performing against the major currencies:
R/$ 8.06
R/£ 13.22
R/€ 11.31

Until next week,

Gareth Stokes
Editor, MoneyWeek SA